PC Connection Inc (CNXN) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the PC Connection fourth quarter conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for your questions following today's presentation. At this time it is my pleasure to turn the floor to your host, Mark Gavin. Sir, you may begin.

Thank you and good morning, everyone. This is Mark Gavin, the Chief Financial Officer. I'm pleased to have you join us today for PC Connection's 2003 fourth quarter conference call. If you haven't already seen our press release you can contact Eileen Gagnon [ph] at 603-683-2322 and she will fax or e-mail you a copy immediately. You can also view it on our website.

Today's call is also being webcast. It will be available from PC Connection's website and at streetevents.com.

Before I turn the call over to Pat Gallup, Chairman and CEO of PC Connection, I'd like to inform our participants that any statements or references made during the conference call that are not statements of historical fact may be deemed to be forward-looking statements. Various remarks that we may make about the company's future expectations, plans and prospects constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking as a result of various important factors, including those discussed in factors that may affect future results and financial condition in the company's annual report on Form 10-K for the year ended December 31st, 2002, which is on file with the SEC. In addition, any forward-looking statements represent our views only as of today and should not be relied upon as represented our views as of any subsequent date. While we may elect to update our forward-looking statements at some time in the future, we specifically disclaim any obligation to do so, even our estimates change and, therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

I'll now turn the call over to Pat Gallup, Chairman and CEO of PC Connection. Pat?

Good morning and, again, thank you for joining us. Bob Wilkins, Executive Vice President, is also on the call with us today. As reported in our press release, net sales for the three months ended December 31st, 2003, increased by $36.2m or 11.2% to $358.4m from $322.2m for the quarter ended December 31st, 2002. Net income for the quarter ended December 31st, 2003, on a Generally Accepted Accounting Principles basis, was $.7m or 3 cents per share compared to $2.9m or 12 cents per share for the same period a year ago.

The three month period ended December 31st, 2003, included special charges that Mark Gavin will comment on shortly. Had these charges not been incurred, pro forma net income for the quarter ended December 31st, 2003, would have been $1.7m or 7 cents per share.

Net sales for the small and medium-sized business, SMB, segment, increased by 19% from the fourth quarter of 2002 to $199.6m and increased sequentially by 11.2% over the immediately preceding quarter. The SMB segment achieved the highest year-over-year growth since the third quarter of 2000.

Sales to government and education customers, the company's public sector segment, decreased sequentially by 13.7% over the immediately preceding quarter, but grew year-over-year by 5.8% to $89.4m. More specifically, sales to the federal government decreased sequentially by 1.8% and decreased year-over-year by 7.1%. Sales to state, local and education customers decreased sequentially this quarter by 25.7% but grew year-over-year by 29.4%.

Sales to large corporate account customers increased by 4.7% from the third quarter 2003 to $69.4m, but remained flat with the corresponding period a year ago.

The fourth quarter of 2003 saw an increase in the number of sales representatives, an increase in the number of active customers, sequential growth in sales form our Internet business accounts program, IBA program, and reduced selling, general and administrative expense or SG&A as a percentage of sales.

During the year we continued our efforts in recruiting account managers. The total number of sales representatives as of December 31st, 2003, increased year-over-year by 11% to 567 from 512 as of December 31st, 2002. Our goal for 2004 is to increase the total number of sales representatives by 12% to 635.

As a result of increased promotional activities, our number of active customers increased by 6% over the fourth quarter of 2002 to 499,000. We believe that the investments we made in building a new Internet business account or IBA program should continue to produce positive results in the first quarter of 2004.

Net sales for IBAs grew sequentially over the third quarter of 2003 by 7% but decreased over the fourth quarter of last year by 11%. The number of IBA users as of December 31st, 2003, expanded to 77,000 compared to 35,000 as of December 31st, 2002.

Total SG&A expenses as a percentage of sales was 9.2% for the fourth quarter of 2003 compared to 9.2% for the third quarter of 2003 and 9.7% for the fourth quarter of 2002. Our year-over-year improved SG&A rates were due to higher sales volumes in the fourth quarter of 2003 and continued cost improvement initiatives.

Gross profit margins decreased this quarter to 10.1% from 10.3% in the third quarter of 2003 and from 11.1% for the fourth quarter of 2002. Gross margins declined year-over-year as a result of more competitive pricing in all three sales subsidiaries. Our ongoing efforts to improve product margins continued to emphasize the enhancement of add-on sales for accessories and consumables, increasing sales of enterprise-class products as a percent of total net sales, increasing account penetrations with PC Connection and third-party, value-added service offerings and a greater focus on solution sales.

In our fourth quarter, net sales of enterprise-class products were 28% of total net sales compared to 27% in the third quarter of 2003 and 28% in the fourth quarter of 2002. We continue to devote significant resources to the expansion of our enterprise-class product offerings and believe additional growth is achievable in this area.

Finally, as we have commented in past conference calls, we remain alert for opportunities in a consolidating market. However, we will only consider acquiring businesses with complementary corporate cultures to add new customers and management talent and that are immediately accretive to our earnings and key operating ratios.

In summary, during the quarter the company grew sales by 11%, reduced expense rates, improved sales productivity, increased the number of sales representatives by 11% and increased the number of active customers by 6%. With the improving economy and accelerating sales productivity, we believe PC Connection is in a strong position in 2004 to gain market share and enhance long-term shareholder value.

Before I turn the call over to Mark, let me product you with a brief update on the effort of our GovConnection subsidiary to regain its General Services Administration, GSA, contract. On January 20th, 2004, GovConnection submitted a proposal to the GSA to obtain a new contract. We are prepared for a pre-approval audit to start any day and be completed by early March. GovConnection hopes to have a new GSA contract in place by the end of the first quarter.

And now I'll turn the call over to Mark.

Thanks, Pat. Average selling prices or ASPs for computers systems decreased during the quarter by about 1% compared to the fourth quarter of last year and increased approximately 2% compared to the third quarter of 2003. This sequential increase resulted from a 6% sequential decrease in server ASPs offset by a 4% increase in notebook ASPs and a 13% increase in desktop ASPs. The year-over-year decrease in ASPs resulted from a 13% decrease in server ASPs, a 5% decrease in notebooks and a 5% increase in desktops. Notebook unit and net sales dollars increased 48% and 40% respectively compared with the fourth quarter of 2002.

Desktop revenues increased 19% year-over-year on a 13% increase in unit volumes. Revenues from server sales decreased 4% while unit volumes increased 10% as compared to the fourth quarter of 2002.

Average order size for the quarter increased year-over-year by 6% to $1202, but decreased sequentially by 8%.

Our improved operating costs are primarily the result of our focus on reducing costs in our core business. Earlier this month the company completed a process improvement initiative in our sales support areas to become more efficient and effective in supporting our sales organization and customers. This effort combined sales support functions together and eliminated redundant positions in the company. This initiative allowed the company to save, on an annual basis, $3.4m.

In addition, since September 1st, 2003, the company has saved an approximately additional $900,000 on an annual basis through reductions in other non-sales areas, bringing the total annual savings since September 1st, 2003, to $4.3m. We continue to review all spending plans and programs to ensure the best possible deployment of our resources.

Total restructuring costs and other special charges included $235,000 after-tax charges for internal review of GovConnection's GSA contract cancellation and $670,000 in after-tax charges related to an uninsured portion of an employee defalcation, a theft. This matter is not related to GovConnection. Because there's an ongoing investigation and we're in the process of trying to recover assets, I'm not at liberty to comment substantively on this matter.

Now let's take a look at the balance sheet. Cash flow generated from operations for the 12 months of 2003 was $3.3m compared to $5m in the same period a year ago. Our accounts receivable were up $9m to $144m on December 31st, 2003, compared to December 31st, 2002, due primarily to increases in sales. Days sales outstanding or DSOs were 47 days compared to 48 days in Q3 and 48 days in Q4 of last year.

Inventory balances increased approximately to $80m at December 31st, 2003, compared to $52m at December 31st, 2002. $6.6m of this increase in inventory was due to higher in-transit inventory, with the remaining increase coming from Apple, $8m, and Toshiba, $4.5m. The higher Apple inventory is due to our Apple-related business growing 70% sequentially and 33% over the prior year period.

Net sales of product drop-shipped by distributors and other vendors directly to customers accounted for 40% of total net sales in the fourth quarter compared to 40% of total net sales in the fourth quarter of last year and 39% of total net sales for the third quarter of this year. Both our federal government and large commercial account business utilize drop shipments heavily to meet their demand.

Inventory turns were 17 compared to 19 in Q3 of 2003 and 20 in the fourth quarter of 2002. Based on quarterly levels, inventory days were 23 on the December 31st, 2003, versus 17 at December 31st, 2002. We believe inventories are in excellent condition, both in quantity and quality. In summary, the balance sheet remains very healthy.

Looking forward, our outlook for the first quarter of 2004 is as follows. Sales to SMB customers are expected to grow year-over-year in the teens. Sales to government and education customers are expected to climb year-over-year in the single digits. Sales to large account segments are expected to increase year-over-year in the mid-to-high teens.

Therefore, for the first quarter of 2004 we presently expect to achieve sales in the range of $305m to $315m and earnings per share in the range of 5 cents to 7 cents per share. We are expecting the gross margin rate as a percentage of sales for Q1 to be in the range of 10.3% to 10.4% and operating expenses as a percentage of sales to be in the range of 9.4% to 9.5%. We continue to work hard to ensure the best possible near-term results consistent with maintaining a strong financial position and investing for the future.

Thank you for joining us today. We will now entertain your questions. Operator?

Thank you. The floor is now open for questions. If you do have a question, you may press the number one followed by four on your Touch-Tone telephone at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We do ask that while you pose your question that you please pick up your handset to provide optimum sound quality. Once again, ladies and gentlemen, that is one followed by four on your Touch-Tone telephone at this time.

Your first question is coming from David Manthey with Robert W. Baird. Please pose your question.

Good morning. I was wondering, Pat, if you could go over the IBA data again. I want to say that you said the number of Internet business accounts were almost double year-to-year but sales were down 11%. Did I get that right?

David, that is correct.

Yes, maybe-- Mark, do you want to comment on the reason for that further?

Sure. David, I think it's we have more actual customers that are utilizing the IBA business site, which bodes well for the future, but in the fourth quarter we had people actually placing smaller orders this quarter, in 2003, compared to last year's quarter. But we have more active people-- we have more active customers actually using the site today.

OK. And the gross profit was a little bit lower than we had expected and I'm wondering if there was some aggressive pricing given that particularly the SMB was much stronger than expected. Was there some big deals at low margin that you took?

No, I wouldn't say that there some big deals at low margins. I think the pricing pressure has been consistent all year long. I think that the strong Q4 results in GovConnection typically carry lower margins and I think that brought the overall margin rate down for the quarter. When I told you about the Q1 of 2004 margin rates, we actually expect them to go up and that's really due to a mix change of more SMB as a percentage of the total sales compared to GovConnection having a lower percentage of the total sales in Q1.

I believe, David, that the levels that we hit in Q3 and Q4 for margin rates are at the low end right now and I expect-- with a lot of the initiatives that Pat mentioned I expect that margin rates in 2004 should be higher than what you saw over the last few quarters.

OK. And then over to GovConnection, have you seen an increase in attrition there? And as far as their compensation goes, are those people being paid at all? I was surprised to see the SG&A so well levered given that Gov should be-- should not be seeing good leverage right now. Could you explain that to me?

Well, first of all, I think GovConnection did an excellent job in Q4 with not having a GSA contract for half the quarter and maintaining business throughout the quarter. They're trying to use other vehicles to-- for their customers. So they've done a good job in converting their customers to other contract vehicles or open-market-type orders.

As far as compensation levels go, we have-- we have guaranteed some of our top account reps in that area for-- through January and most of the quarter at levels that we paid them for last year. I think GovConnection's done a good job on holding on to some of the most valuable reps in GovConnection. We have lost a few, but overall I think it's a net positive in getting through this difficult period of time.

OK. And then my final question is on the core business. I guess I'm just surprised to hear you say that you're looking for acquisitions in a situation where the core business is still, I think, in trouble. Can you talk about the core business? Was there any profitability there this quarter and I understand you're doing some things to try to fix the core business--

Well, you--

--but I don't know that incremental change is needed today. Is there anything that you--

Sure.

--you're looking at that would be broader than that?

David, I think your characterization of the core business as in trouble is not the correct characterization. If you look at the growth that we achieved in the SMB segment, close to 20%, that's the highest growth we've achieved in the last couple of years. So they're really coming back strong here and that means good things for the future.

As far as fixing some of the issues in the core business, for expenses, you heard me speak about reducing some expenses through sort of our sales support areas and we were able to reduce $4.3m out of our expense structure. That will mean good things for the remaining part of 2004.

So your characterization, I don't agree with it. Core activity is improving. Overall sales is growing year-over-year and I expect that margins will improve as some of the initiatives that Pat mentioned really take hold in 2004.

OK. Just a follow-up on that. So are you saying that the core business-- did the core business make money in the fourth quarter, meaning SMB And GovConnection? And then if you could talk about, with these expense reductions, what are your goals for profitability in 2004?

Our goals for-- core business will be definitely profitable in 2004. So we expect good results from them. As far as talking about the profitability, I really can't at this time for Q4. I'm precluded from giving any additional non-GAAP measurements right now. But as far as looking forward with the expense reductions and some initiatives we have in place to increase sales performance there, I'm expecting that 2004 will be a very good year for the core business.

OK. Thanks, Mark.

Thank you. Our next question is coming from Brian Alexander with Raymond James. Please pose your question.

Yeah, just to go back to the pricing, Mark, I think we've been, you know, looking for gross margins to improve for the last few quarters and if I look at this quarter it looks like, while your revenues were strong, your gross margins were down rather significantly year-over-year for all of your segments.

Correct.

So I'm just trying to figure out when are we going to start to see gross profit dollars grow along the lines of sales and what is your pricing strategy? I guess we're not hearing a lot of-- or seeing a lot of gross margin pressure from some of your competitors. In fact, we're seeing better gross margins and they're putting up some decent sales numbers, as well. So where is the pressure coming from? What products, what competitors?

I think the pressure is really in the systems area, in the notebooks and desktops and the real key to improving gross margins in 2004 will be attaching accessories to those sales and service plans to those plans and increased enterprise products sales. We're really working on that hard, Brian, and as I mentioned to David, I expect to have improvements in 2004 in gross margins.

Am I disappointed with the rates that we had in the last couple of quarters? Absolutely. And if you talk to the management here, it's something I talk about every day and we're working hard to bring those margin rates up in 2004.

OK. Could you let us know how much of the $4.3m annualized expense savings did you actually realize in the fourth quarter? How much incremental will you realize in the first quarter?

I would say probably on an annualized basis I would say probably $300,000 of that was realized in the fourth quarter. The majority of it was realized in the third quarter. Well, $900,000 was realized in 2003, $300,000 of it was realized in the fourth quarter. The remaining $600,000 in the third quarter and so the other savings that I mentioned that we did earlier this month took place about halfway through this month. And so we're going to have a good impact in Q1 from those savings.

So of the $3.4m annualized for this year, half of that was achieved in the fourth quarter on a quarterly run rate?

No. It was $4.3m of total savings I spoke about. $3.4m of it took place in January of this year.

OK. From a product standpoint, it looks like the networking category was down sequentially and I think your not alone on that. A couple of your competitors have reported weakness in their networking category. And then also on the positive side, software looks to have been a pretty strong category in the fourth quarter. I think your dominant vendor on the networking side and on the software side is Microsoft, so I assume that they're contributing to the strength and weakness that we're seeing.

Maybe if you can just put some color on what's going on in each of those categories?

Hey, Brian, it's Bob. I'm going to go back to the margin issue just real quick to follow-up with what Mark was saying.

You know, margin overall is caused by three actions. One is your ability to purchase at a low price. Two is your pricing structure out to your customers and three is your mix change. And there's been a lot of initiatives in late Q3/Q4 to change all of those. So we do expect this year to be an improvement in the overall gross margin you see in the market place. Some of those were from system changes, others were through policy changes and others were through restructuring of the purchasing department to get more aggressive in our buying habits.

Along the mix change, this quarter or next quarter we'll start seeing some growth in the Microsoft. You know we're on the second round of the annual renewal program for the [inaudible], the Advantage program. So we expect to see some pickup there.

We have brought on some new personnel from some competitors, which will help in some of our software areas. We're picking up some new lines we weren't focused on in the past.

On the Cisco piece, it really was looking at a profitability issue and how much margin we're making on that. That's an interesting line. The minute you move up into the mid-size enterprise you compete with a lot of the VARs in the market and we think there's some other vendors out there we can actually make more profit in the SMB market. So you might see a shift mix in Cisco going to some other vendors going forward.

OK. Back to the Microsoft, Bob, how much of the-- if you could just ballpark, how much of the strength that you saw in the fourth quarter was attributable to or attributed to renewals of Upgrade Advantage that were bought two years ago?

Really not much in the fourth quarter. We expect all that's going to happen in late Q1 and really into Q2. We saw some other software lines that came on that helped. Adobe was fairly strong and CA was coming on, so, again, it's some new vendors and some growth from that point.

And when we look at the inventory, Mark, that you-- I think you touched on a couple of the reasons why inventory was up significantly in the quarter.

Sure, right.

How much of that relates to this shift in purchasing strategy where maybe you're getting a little bit more aggressive by buying larger quantities and stocking more inventory?

I think some of that took place in the month of December. So we didn't see a lot of results from that in Q4. I expect more or better purchasing patterns in Q1. So we started that new initiative towards the beginning of December.

And, again, on all those inventories, they're completely price-protected going forward.

OK. And then on the Apple strength that you saw this quarter--

Yes.

I assume a lot of that is share gain and I'm wondering is that more on the consumer side or is it on the commercial side?

Yeah, we've done a good job, really, on the Pro line. If you look at us compared to the competitors from what Apple tells us, we have a higher percentage gain in the Pro series, in the servers and in the G5s. We've never been real strong in the iMac line, so it really was in the SMB sector.

And then finally, your headcount was down quarter-to-quarter by about 13. Was that planned? And which segment did you see the attrition?

That was planned. You typically don't do a lot of hiring towards the end of the year, so we had people leave during the quarter that we did not replace. We expect that hiring will continue in 2004 as we spoke about, increasing around 12%. As far as what segment it was, it was really-- the majority of it was in SMB and some in Gov.

Great. Thanks, guys.

Yeah.

Once again, ladies and gentlemen, if you do have a question you may press the number one followed by four on your Touch-Tone telephone at this time. I'm showing no questions at this time. I would like to turn the floor back over to the speakers for any further comments.

I just want to thank everyone for your time and have a great day. 'Bye-bye.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.